The Economic Impact of the Deep Water Horizon Disaster on the Local Seafood Industry

Imagine that the United States is preparing for the outbreak of an unusual Asian disease that is expected to kill 600 people. Two alternative programs to combat the disease have been proposed. Assume that the exact scientific estimates of the consequences of the programs are as follows. Program A: If Program A is adopted, 200 people will be saved. Program B: If Program B is adopted, there is a one-third probability that 600 people will be saved and a two-thirds probability that no people will be saved. Which of the two programs would you favor? Big Gamble Choose: (a) receive $10 million for sure (expected value = $10 million) (a) flip a coin and receive $22 million for heads but nothing for tails (expected value = $11 million). Lawsuit You are being sued for $500,000 and estimate that you have a 50 percent chance of losing the case in court (expected value = –$250,000). However, the other side is willing to accept an out-ofcourt settlement of $240,000 (expected value = – $240,000). Would you: (a) fight the case (b) settle out of court? Utility instead of value Daniel Bernoulli What Do People Choose? Decision A 0 10 20 30 40 50 60 70 80 90 Option A (sure gain) Option B (uncertain gain) Percent Choosing Option Decision B 0 10 20 30 40 50 60 70 80 90 100 Option C (sure loss) Option D (uncertain loss) A change in the ‘‘framing’’ of choices— in this case, from losses to gains—can dramatically affect how people make a decision We evaluate outcomes relative to a neutral reference point. Sell or Hold? You were given 100 shares of stock in XYZ Corporation two years ago, when the value of the stock was $20 per share. Unfortunately, the stock has dropped to $10 per share during the two years that you have held the asset. The corporation is currently drilling for oil in an area that may turn out to be a big “hit.” On the other hand, they may find nothing. Geological analysis suggests that if they hit, the stock is expected to go back up to $20 per share. If the well is dry, however, the value of the stock will fall to $0 per share. Do you want to sell your stock now for $10 per share? Preference Reversals • Sub-optimal decision portfolios • “Pseudocertainty” and our judgments • Insurance • Evaluations of transactions • Endowment effect • Mental accounting • Bonuses versus rebates • Separate versus joint evaluation Framing and the Irrationality of the Sum of Our Choices Imagine that you face the following pair of concurrent decisions. First, examine both decisions, and then indicate the options you prefer. Decision A Choose between: a. a sure gain of $240 84% b. a 25 percent chance to gain $1,000 and a 75 percent chance to gain nothing Decision B Choose between: c. a sure loss of $750 d. a 75 percent chance to lose $1,000 and a 25 percent chance to lose nothing 87% Framing and the Irrationality of the Sum of Our Choices Choose between: e. a 25 percent chance to win $240 and a 75 percent chance to lose $760 f. a 25 percent chance to win $250 and a 75 percent chance to lose $750 86% Preference “reversal”… Think of portfolio selection, budgeting, and funding for new projects, etc… The “certainty” effect Russian Roulette Question 1 How much would you pay to remove the bullet and reduce the likelihood of death from 1/6 (17%) to 0? Question 2    

Sample Solution